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Behavioral Economics

Behavioral Economics



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Published by Ryan Hogan

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Published by: Ryan Hogan on Dec 03, 2009
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“Behavioral Economics” (Collin Camerer) and“Incentives and Self-control” (Matthew Rabin)To appear in
Advances in Economics and Econometrics Theory and Applications, Ninth World Congress 
Ariel Rubinstein
School of Economics, Tel Aviv University andDepartment of Economics, New York University20 August 2005I would like to thank Rani Spiegler for the many discussions we had on BehavioralEconomics during the last few years. I could not imagine writing this essay without thebenefit of his comments, insights, ideas and criticism.Page 1 7/1/2006
1. What is the Behavioral Economics “Revolution”?
For me, economics is a collection of ideas and conventions which economistsaccept and use to reason with. Namely, it is a culture. Behavioral economicsrepresents a transformation of that culture. Nonetheless, as pointed out by Camererand Loewenstein (2003), its methods are pretty much the same as those introducedby the Game Theory revolution. At the core of most models in Behavioral Economicsthere are still agents who maximize a preference relation over some space ofconsequences and the solution in most cases still involves standard equilibriumconcepts. However, the behavioral economists are not committed to what is usuallyreferred to as rational motivations. An economic fable (or a model as we would call it)that has at its core fairness, envy, present-bias and the like is by now not onlypermitted but even preferred.Why now? Perhaps, economists have finally realized that orthodox economicmodels are too unrealistic and dogmatic. And perhaps it is the result of our constantsearch for new directions in research. One might also ask why other ideas (such asthose of bounded rationality) are less welcome than those of Behavioral Economics. Ithink that this is because the profession prefers progress in small steps. The modelsof Behavioral Economics are not that different from those of applied economics andthus are not perceived as a threat.The extent of this transformation may go beyond the topics discussed in thissession. For example, Behavioral Economics may influence the way economics isapplied to political issues. It also reintroduces ideological questions such as to whatextent governments should paternalistically “repair” biases and fallacies.
2. Theoretical Behavioral Economics
A paper in Behavioral Economics typically begins with a description of a real lifephenomenon that cannot easily be explained by the standard rational man paradigm.To support the case, references are brought from research in psychology andsometimes even studies of animal behavior. In Rabin’s discussion all that is borrowedfrom psychology is the idea that
people, in
cases, have
Page 2 7/1/2006
present-bias. I doubt we need psychological justification in order to make thatassumption. Each of us can think of situations in which we exhibit present-bias.However, it is also easy to think of situations where we have
bias. Forexample, say, I have one piece of expensive chocolate. Whenever I am about to eatit, I think to myself: why not leave it for the future and enjoy the feeling of expectation.The outcome: I leave it to so long that it is no longer edible. The Psychology literaturetries to understand the circumstances where a phenomenon exists. But, in order to just assume that present-bias often exists, it is sufficient to cite casual observation asis done in other fields of economics.The typical paper in this field then moves on to modeling the bias. The basicframework used to model present-bias is not new and goes back to Strotz (1956).What is new is that time inconsistency is being applied to a variety of economicsettings. Ten years ago it was difficult to publish a paper in the QJE which included a“present-bias” assumption. These days it is almost impossible to publish a paper inthat same journal which ignores present-bias, let alone one which criticizes theapproach...O’Dononghe and Rabin adopted the
model. Rabin repeatedly makes thepoint that the standard time consistent model is wrong and that the
model iscorrect. I agree that the
model is a very interesting example of an analyticallyconvenient functional form but I find the claim that these models are more accurateand realistic to be misleading. Note that the introduction of time inconsistencyrequires the addition of strong assumptions about the way that different selvesinteract. In order to complete the model, behavioral economists resort to the standardassumptions. Usually these involve either naive or sophisticated agents. Naivete isnot realistic since agents never learn. Sophistication is unrealistic since it suffers fromthe problems of subgame perfection. An agent is super-rational in the sense that heperfectly anticipates his future selves and arrives at equilibrium between them.Present-bias is a realistic phenomenon, but the combination of the
preferenceswith naivete or sophistication assumptions makes the model even more unrealisticthan time consistency models.Rabin goes out of his way to beat, if I may use his own phrase, the “dead parrot” offull rationality. Of course there are many facts that are hard to reconcile with fullrationality. But the psychology and economics literature has replaced a dead parrotPage 3 7/1/2006

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